The Bull Bear Trader discusses market events and news with an interest in understanding risk and return in both bull and bear markets. Discussion topics include trading and hedging strategies, derivatives, risk management, hedge funds, quantitative finance, the energy and commodity markets, and private equity, as well as an occasional investment opinion.

Wikinvest Wire

The Nasdaq is planning to launch a series of trading and investment products based on companies receiving TARP money (see WSJ article). The first is the GRI (Government Relief Index), tracking 24 companies that received over one billion dollars in bailout assistance. The index is being pushed as a way to track the effectiveness of the TARP, yet it seems that for the index to be successful (profitable), it either needs to be widely followed and reported, or used as a vehicle to be traded against. The first seems unlikely (since many will argue that the success of TARP is not based simply on the individual companies doing well), and the second seems counter-intuitive, or at least counterproductive. Given a potential ETF product, it is not exactly clear how making it easier to short the companies in trouble and needing assistance helps the recovery. Maybe a simple "dead or alive" count would be easiest, but even that is difficult to gauge. Is Bear dead or alive? How about Merrill? Fannie or Freddie?

Crude oil is currently in contango as futures are trading at a significant premium to spot prices (see WSJ article). As of yesterday's close, spot prices were around $43 a barrel as May futures were trading near $50 a barrel. Unfortunately, to profit from the difference, you need to store the crude somewhere, yet the number of available tankers is decreasing fast. In fact, demand is causing shipping prices to rise nearly 50 percent recently, causing a increase in the Baltic Dirty Tanker Index.

Fund managers are gearing up for a fight regarding short selling disclosure rules (see Financial Times article). The FT article discusses how the fund industry would be damaged by such timely and public disclosures, basically arguing that no one would pay for investment advice or money management when the relevant information can be had for free a day or so later. Yet, this argument may miss the most interesting point - that a ban or disclosure rule is certain to have some unintended consequences.

Bans on short selling have had a goal of trying to limit funds from manipulating the market, but making short selling positions public could just exacerbate the problem. Non-public disclosure would allow regulators to monitor positions and funds, insuring that market manipulation was not occurring, yet by making the short data public, others would now be tempted to jump on the momentum train, increasing their short positions, and the selling pressure on the shorted security. In the end, this may do nothing to decrease market manipulation, while still allowing the funds to profit from the falling prices.

If increased selling is the potential fall-out of public disclosure, then why should funds care? I suspect there are two reasons. First, if they are taking a large (but allowed) short position, it may take more than a day to enter or exit the position. One day of disclosure could potentially reduce the profitability to the fund as others front-run the trade. Second, and maybe more critical, is that any short momentum trades that result in a large sell-off or company failure will still ultimately get blamed on the funds, causing regulators to once again implement short-selling bans. For the funds that have strategies that rely on being able to take a short position, such a ban affects viability as much as it does profitability.

Currently, longer disclosure periods are being discussed, such as two weeks or even a month. While this may help with the first problem of having enough time to enter and exit a position, it will do less for the second unless the disclosure period is long enough to limit profit opportunities for those who later try to mimic the trade. Too short a disclosure period, and you encourage copy-cat trades and additional selling pressure. Too long, and the disclosure simply becomes a record of what companies were short. Anything in between provides the potential for market manipulation with little benefit to market efficiency over what non-public disclosure would most likely offer.

Following the recent comments of Yale's endowment investment chief, David Swensen (see previous post), over half of a group of recently surveyed asset managers believe that high-quality corporate credit is currently trading at cheap levels and will likely rally in 2009 (see Financial Times article). Many feel that the rush to the safety of Treasuries has caused all grades of corporates, even high-grade bonds, to be oversold. On the other hand, many of the same analysts, including Pimco's Mohamed El-Erian, feel that US Treasuries will face considerable pressure after their recent fear-driven price appreciation, which in some cases drove yields to near zero levels for some shorter duration issues. Given the current desire by the incoming Congress and the President-elect to fund numerous public sector and infrastructure projects, the government will be forced to increase its issuance of debt, putting further pressure on Treasury prices.